Introduction to Graded Surveillance Measure

Are you interested in the world of stock market investing? It’s a thrilling and potentially rewarding field, but there are also risks involved. That’s why we have the Securities and Exchange Board of India (SEBI) to oversee and regulate the market. 

However, maintaining the balance between promoting investments and protecting investors from fraud is no easy feat. This is where graded surveillance measures (GSM) come in. 

In this article, you’ll learn all about GSM – what it is, how it works, and, most importantly, how it affects investors. 

What is graded surveillance measure?

Graded surveillance measure refers to a framework created by stock exchanges under the guidance of SEBI to monitor specific stocks based on observation of abnormal price rises not commensurate with financial health and fundamentals. The idea is to alert investors from getting carried away by such abnormal rallies even as investigation is on to understand the reason behind the price rise.

The concept of graded surveillance measures has been there for a long. Still, a well-defined structure for monitoring stocks based on the rise in prices and volumes was put in place by stock exchanges in consultation with SEBI in February 2020.

How does graded surveillance measure work?

Under the graded surveillance measure framework, stocks identified for abnormal price rise are put under different stages, starting from Stage I to Stage VI, based on the level of price rise. The higher the level, the stricter the restrictions imposed on trading with the objective of restraining trading.

1. Stage I involves stocks that are of particular interest to the market and are watched more closely, with their prices only allowed to move up or down by a small percentage rather than the usual larger amount. 

This gives the exchange time to look more closely at the company behind the stock to make sure everything is as it should be. If there are any concerns, further restrictions may be put in place until everything is resolved.  

2. In Stage II, certain stocks were identified and were required to be traded under special rules called Trade for Trade settlement. This meant that these stocks could not be traded for speculative purposes, and the shares had to be delivered upon payment. 

To buy such stocks, the buyers had to pay the full amount upfront to block the entire value of the shares. If these rules were not followed, further stages were activated.

3. Stocks in Stage III are put in a category called Additional Surveillance Measure (ASM). To trade in ASM stocks, you need to have a 50% margin and buy/sell the full amount of the stock. Only clients with enough money or shares can trade in ASM stocks. 

4. Stage IV refers to a set of rules that restrict the trading of certain stocks to once a week and require traders to put up more money upfront when buying these stocks. 

These rules are in place to prevent excessive speculation and promote responsible investing. 

However, investors are still allowed to sell their stocks freely, and companies are permitted to take certain actions that might affect the value of these stocks.

5. In the final stage, i.e. Stage VI of monitoring, a specific stock is traded only once a week and is closely watched by the exchange to ensure its safety and stability. 

During this time, the amount of money required to be held in reserve for the stock is at its highest 100% until the graded surveillance measures 11 period is over.

The stock is only removed from this stage-by-stage monitoring process when its performance in the market improves.

Purpose of graded surveillance measure  

The prime purpose of additional graded surveillance measures is to protect investors’ interest by providing them with timely caution messages when regulators detect abnormal price movements not supported by fundamentals. The idea is to avoid investors getting carried away by sudden spurts and buying into stocks without realising the artificial rally.

Exchanges have surveillance systems to detect such rallies outside the financial health of the company. By imposing restrictions on identified stocks in a graded manner, a buying rage is contained temporarily, allowing exchanges to seek clarification from the company. If the explanation is convincing or satisfactory, the stock faces higher curbs. 

Some key objectives of the graded surveillance measure framework:

1. Alert investors about possible risks by identifying stocks with abnormal rallies

2. Discourage excessive speculative trading not linked to fundamentals

3. Conduct a fair investigation by obtaining company clarification  

4. Impose graded restrictions to contain abnormal price rise

5. Permit exit option to existing investors caught on the wrong foot  

6. Subject identified stock to the highest level of monitoring  

The GSM system tries to balance investor interest even while an investigation is on. It avoids the knee-jerk reaction of suspending trade without understanding the reasons. Graded curbs allow trading while alerting people.

How does stock identification happen for GSM?

The exchanges use various alerts and inputs to detect abnormal price rises or activity not commensurate with the financial strength of the company. These inputs act as triggers to take a closer look at potential candidates for shortlisting under GSM.

Some parameters generally used by exchanges for surveillance include:

• Sudden spurt in stock price or volumes not in sync with financial health 
• A company having negative worth, no actual business operations showing inflated profits/volumes in stocks
• Disproportionate promoter holding and trading activity compared to the size and scale of the company  
• Stock valuation, price multiples way above industry averages, balance sheet size 
• Credible complaints of price manipulation or accounting fraud  
• Finally, manual surveillance combined with automation triggers

Impact on investors of additional graded surveillance measures

Imposition of additional graded surveillance measure 13 can negatively impact short term investors or traders caught on the wrong side of abnormal rallies. With curbs on speculative trading and restrictions kicking in, existing holders are stuck with stock and face a loss in value.

However, over the medium to long term GSM framework is seen positively, given objective is to protect unsuspecting investors from falling trap to possibly manipulated stocks or fly-by-night operators. The graded approach avoids the knee-jerk reaction of suspension of trading without allowing an exit option or understanding the reasons behind the abnormal price rises.  

Once fundamentals were proven and the influence of speculative activity denied, stocks gradually eased out of restrictions, permitting investors to sell and exit. Some stocks justified the abnormal price spike through convincing fundamentals explained to exchanges, allowing denial to be lifted.

Thus, Graded Surveillance Measures impose short-term pain for long-term good by educating investors on the pitfalls of stocks with abnormal rallies. GSM stresses the need for understanding fundamentals over trading mentality in stocks.  

Conclusion

SEBI has introduced Graded Surveillance Measures (GSM) to avoid excessive speculation in stocks and alert investors about abnormal price rises. The system educates stakeholders to avoid stocks with abnormal rallies that are not justified by financial strength or fundamentals. It limits damage until the completion of the investigation by exchanges. GSM strengthens market integrity and transparency, encouraging sustainable investments.

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